We keep our oil price forecast of USD65/bbl unchanged while anticipating oil prices to remain stable in the longer term through collaborative efforts from OPEC and nonOPEC allies. Consequently, we foresee a gradual increase in activities for the space. Domestically, we believe activities moving forward would be skewed towards maintenance works as Petronas is still cautious and anticipating a ‘lower for longer’ environment coupled with potentially restricted capex headroom from higher oil royalties promised by the PH Government to Sabah and Sarawak. In terms of earnings, despite the increase in contract awards seen, we foresee earnings for local O&G service players to remain volatile for 2H18 as most projects are still in infancy stages. As such, we maintain NEUTRAL with positive bias on the sector underpinned by healthier oil prices with preferred picks being SERBADK (OP; TP: RM3.90), YINSON (OP; TP: RM5.30) and DIALOG (OP; TP: RM3.80).

USD65/bbl forecast unchanged. We opine that current oil prices are stable, buoyed by collaborative production cuts among OPEC and non-OPEC members providing for healthier oil prices with less volatility moving forward. While US shale production is on the rise, we are anticipating production growth to be gradual due to production bottlenecks from infrastructure and logistics. Overall, we keep our long-term average oil forecast maintained at USD65/bbl.

Petronas and Petros at loggerheads. Petros (Sarawak’s O&G company launched in March 2018) is claiming rights to be the sole regulatory authority for the upstream and downstream oil and gas industry in Sarawak. We understand that being the regulator does not mean taking ‘ownership’ of the oil assets (which still belongs to Petronas) but rather the body setting the rules for contractors and operators in Sarawak’s oil and gas fields i.e. imposing local content into Production Sharing Contracts (PSC), licensing fees, and many others. Petronas has challenged Petros’ claims by filing a case to the Federal court but was shortly dismissed as the Federal Court cited that the case does not fall under its purview but the High Court. As such, we anticipate Petronas to continue pursuing the case and expect this on-going tussle to persist possibly delaying awards of Sarawak-based PSCs. Note, Petronas has opened up 9 exploration blocks for bidding in Jan 2018, of which 4 fields (SK328, SK427, SK433, SK334) are located within in Sarawak’s boundaries.

Increase in oil royalties might limit Petronas’s capex headroom. Under the PDA 1974, Petronas currently provides 5% of oil royalty each to the State (where the oil is found) and Federal government. However, with the recent switch in government, we believe oil royalties would be increased to 20%, promised in the PH manifesto. While timeline of the implementation remains vague given the ongoing tussle for regulatory rights, the move to increase royalties is unlikely to affect Petronas’s FY18 capex of USD55b as capex allocations are typically long-term plans which are subject to little changes once finalised. That said, once the royalties hike is implemented, we think that Petronas’ capex moving forward might be exercised with greater prudence due to the potentially lower net revenue. Coupled with the recent abolishment of GST (and reinstatement of SST which is expected to generate lower government revenue), we think that there might be greater reliance over Petronas’s dividends to finance government plans – which could also limit Petronas’s capex allocations in the near term. All being said, we believe maintenance activities (Brownfield HUCs and MCM) would increase in order to maintain asset uptime as Petronas commits to their 1.7m bboe/day production target.

Earnings remain unexciting. On the back of the healthier oil prices, we believe the sector is currently at an inflection point whereby contract flows are seen to be picking up; but earnings which have been depressed have not caught up as projects are still in infancy stages. Hence, we are still anticipating modest and volatile earnings on the local service subsectors i.e. OSV, offshore fabricators and rig owners for the remainder of FY18. On a brighter note, we see a silver lining within the OSV space with the recent Integrated Logistics Control Tower (ILCT) contract (consisting two fast crew boats) awarded to EATECH (Not Rated). We believe this contract could be a precursor for larger packages as the ILCT programme initiated by Petronas could require up to 110 vessels.

Maintain NEUTRAL with positive bias. With volatile earnings still expected in the near term for some counters under our universe, we remain NEUTRAL on the sector with positive bias backed by the improving sector outlook underpinned by stable oil prices. However, in view of Petronas’ anticipation for a ‘lower for longer’ environment while expecting flattish capex allocations, we prefer counters with: (i) higher proportion of foreign exposure, (ii) recurring incomes, and (iii) earning delivery track record. Hence our preferred picks include: (i) YINSON, (ii) DIALOG, and (iii) SERBADK. Note, the commencement of Pengerang Integrated Complex (PIC) next year would bring in additional income stream for: (i) DIALOG through Pengerang Terminals 2, and (ii) SERBADK as it gradually starts out an MRO space for onshore maintenance services.

Source: Kenanga Research - 5 Jul 2018